The PACER PERSPECTIVE
Overcoming Home Country Bias and
Seizing the International Opportunity.
- Michael Mack, Portfolio Manager
Based on our conversations with financial advisors, most admit they don’t have enough international exposure. The majority believe there may be a significant opportunity in the international space going forward and investors should see if it is a good fit for their portfolio or not.
Currently, 27% of assets in the equity ETF universe are international ETFs. However, in the FTSE Developed Large-Cap Index, 42% of its stocks are international. So why aren’t people investing more internationally? A common reason advisors and investors don’t have more international equity exposure is because of home country bias. This term refers to the preference of investors to overweight their domestic exposure relative to the rest of the world. In other words, they want to own equities they are familiar with.
Investors are hesitant because of a few risks of international investing.
- They don’t trust companies they are not familiar with.
- They think they can achieve everything they want through a portfolio of US stocks.
- They view international stocks as risky investments.
- They are concerned about currency exposure.
- It may be difficult to find the information on individual international equities needed to make an educated decision.
Allocation to International Equities
as of 9/30/16
Lately, the “domestic only” mindset has worked out in favor of US investors. Since 11/30/2007, US equities have outperformed international equities by 6.64%1 annually, and we are nearly 9 years into a cycle favoring domestics over international. Historically, the average life of these cycles is less than 5 years. Owning US equities was the right decision over the past decade, but looking forward the case may not be as strong.
Source: FactSet and ETF.com
(1)US equities, as represented by the S&P 500®, have outperformed international equities as represented by MSCI EAFE from 11/30/2007 to 9/30/2016.
How can an investor best prepare for this cycle and the one after?
Investing in a global fund allows investors the opportunity to gain international exposure while maintaining a position domestically, unlike international funds which include strictly foreign stocks. As mentioned, the cycle between international and domestic equities changes every few years. Choosing a global fund instead of an international fund may prepare investors for either side of this cycle. It also offers a few other benefits:
1) Takes advantage of the higher liquidity in US equities
2) Reduces foreign dividend taxes
3) Buffers the portfolio during domestic and international shocks like Brexit and the Greek debt crisis
Performance Before and After Brexit
May 31, 2016 - July 29, 2016
Source: Bloomberg. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. You cannot invest in an index.
As displayed in the above chart, leading up to and after the Brexit scare on June 23, 2016, the MSCI World Index (a global index) offered a less volatile ride than the international index (MSCI EAFE). Owning a global fund helps buffer headline risks and the associated shocks to international markets while providing the opportunity to take advantage of lower valuations abroad.
We’ve made a case for investing globally, but there are a lot of funds. How do you pick one?
The concerns about international investing mentioned earlier are legitimate and should be considered when selecting the appropriate fund. A traditional market cap weighted international index owns 500 or more stocks, but not all of those stocks are the quality names that investors prefer to own. At Pacer, we follow a few rules in order to offer quality investments:
1) We use a rules-based discipline and own a fund rather than individual companies.
2) We use a global benchmark index rather than an international index.
3) We screen for stocks based on specific qualities in order to meet our objectives.
Our Pacer Global High Dividend ETF (PGHD) uses a rules-based methodology to select only the names that meet the criteria set out for identifying quality stocks. The quality screens we use for PGHD are free cash flow yield and dividend yield.
Free Cash Flow Yield & Dividend Yield.
Free cash flow (FCF) yield - A high free cash flow yield signals a company’s management is disciplined enough to save some, rather than spend all of the cash the business generates. In addition to being a positive signal of profitability and good management, free cash flow yield also provides a ballpark figure for what the payback period would be for investors to get their money back. The higher the free cash flow yield, the shorter the pay back period.
Dividend yield - Paying a dividend signals a company’s management is confident in the future and can return cash back to its shareholders. In addition, a high yielding stock tends to have less downside because the dividend can help balance the stock price.
Expanding a Portfolio.
Expanding a portfolio to be global broadens opportunities for investors while still maintaining a domestic position. However, investors should not choose investments blindly to fill a gap in the international portion of their portfolio. Instead, select a global fund of quality equities, like GCOW, and be prepared for the next cycle change.
Uses a free cash flow yield screen and a dividend yield screen to invest in 100 companies from the FTSE Developed Large-Cap Index. It aims to provide a continuous stream of income and capital appreciation over time by screening for companies with a high free cash flow yield and a high dividend yield.
This document does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Please consult with your financial advisor and tax advisor before investing.
This document is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. This document represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. The user of this information assumes the entire risk of any use made of the information provided herein.